Bad explanations for inflation | AIER

Although it is empirically difficult to decompose inflation into its component parts, its essence is simple. Inflation occurs because too much money is chasing too few goods. Milton Friedman popularized this rule. Its combination of comprehensibility and explanatory power explains why it is still widely used today.

But not everyone received the memo. Politicians, bureaucrats, journalists and Very Online™ scientists are actively looking for other causes. Let’s look at a few bad explanations for inflation.

“Greedy corporations!”

A favorite of congressional progressives, especially Senator Elizabeth Warren, this explanation is the worst of all. Corporations are always greedy. They want to make as much profit as possible. However, inflation is rarely as high as it is now. The last time we saw the dollar depreciate so quickly was 40 years ago. You cannot explain a variable effect by a permanent cause. Gravity does not cause a person to stumble and fall. Greed does not cause inflation.

“Market power!”

In economics, “market power” refers to the ability of firms to set prices above marginal cost. Proponents of explaining inflation by market power point to increased concentration in several industries over the past two years.

Suppose for the sake of argument that the concentration of the industry has increased. This still doesn’t explain inflation.

First, the relationship between concentration and market power is weak. Sometimes concentration is driven by structural economic factors – an effective response to changing economic circumstances. When this happens, there is no corresponding increase in market power.

Second, the market power argument is confusing. level prices for growth rate prices. Inflation is one of the latter. Even if market power allowed firms to raise prices, this would be a one-time event. Inflation will temporarily jump and then return to the trend. Instead, we had a long period of above-trend inflation. It just doesn’t add up.

“The Spiral of Wages and Prices!”

Some bad explanations never die. The wage spiral view was the basis of Keynesian (pseudo) theories of inflation from the mid to late 20th century. It was bad then and bad now.

Presumably, rising prices cause workers to demand higher wages, leading firms to charge even higher prices to break even. This is positive feedback. But it has two serious drawbacks. One conceptual. Another actual one.

Conceptually, it makes no sense for wages to outstrip labor productivity. Firms cannot afford to pay workers more than the value these workers add to the firm’s profits. If you own a sandwich shop and think that hiring a potential employee will add $15 an hour to your income, what is the maximum amount you are willing to pay him for the job? You will lose money if you pay him more than $15 an hour. The dollar figure of worker output, which economists call marginal revenue product of laboris the upper wage limit.

In fact, inflation outpaced wage growth for several months. The CPI rose 8.6% year-on-year, while nominal (in dollar terms) wages rose only 5%. This means that the workers actually took a pay cut (i.e. after adjusting their wages for inflation). What is the spiral of prices and wages? Anyway, the firms make a deal!

“Price push!”

I’ll take a beggar question for $400, Alexey! This theory of inflation states that businesses pass (“push”) higher costs onto consumers in the form of higher prices. But this is not an explanation. This is just a repetition of what needs to be explained. Why are costs rising? You are back where you started.

Improving public discourse

Let’s hope that these lousy explanations will soon disappear from the public consciousness. We need to focus on what matters: the relative abundance of money over goods. To be clear, this does not mean that inflation is 100% dependent on the money supply. I am sure that the remaining supply chain problems due to the pandemic and the ongoing war in Ukraine are part of the problem. In addition, we must be careful when weighing money and money. non-monetary factors.

to me Sound Money Project colleagues did a good jobhere, here, here, hereas well as here very recently) showing money is a big deal right now. This is not the whole explanation, but most of it. Armed with this knowledge and inoculated with some of the silly explanations circulating today, we can work on policy solutions to regain control of the value of the dollar.

Alexander William Salter

Alexander W. Salter

Alexander William Salter is Georgie Snyder Associate Professor of Economics at the Rawls College of Business and Comparative Economics Fellow at the Texas Tech University Free Market Institute. He is a co-author Money and the Rule of Law: Generality and Predictability in Monetary Institutionspublished by Cambridge University Press. In addition to his many scientific articles, he has published about 300 articles in leading national publications such as Wall Street Journal, National review, Opinion Fox Newsas well as Hill.

Salter received his M.A. and Ph.D. in economics from George Mason University and a bachelor’s degree in economics from Western College. He was a member of the AIER Summer Scholarship Program in 2011.

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